M&A East: Add-On Deals

The Merger Verger just returned from M&A East, perhaps the preeminent middle market acquisition event of the year in this part of the world. M&A East is put on by the Philadelphia chapter of the Association for Corporate Growth and is very well done and very well attended.

While most of the attendees come for the rich networking opportunities, there are also work sessions and presentations … actual “content.”  The Merger Verger attended one roundtable session dealing with the large role that the Buy-and-Build strategy and add-on deals are playing increasingly in the private equity world.

We noted a number of interesting or useful points:

• The Buy-and-Build investment strategy has both the advantages and disadvantages of focus: wisdom, experience and increasing market power and multiple arbitrage on the upside; concentration and lack of diversity on the down side. Pick your poison.
• Market fragmentation can be an important attribute of a sector appropriate for Buy-and-Build but it requires some perspective and caution (read “better due diligence):
  • Is fragmentation the result of incremental market development over time or some fundamental customer or sourcing requirement?
  • A market that has long been fragmented may have an entrenched fragmented purchasing process on the customer side, making the synergy potential of national footprint harder or slower to realize.
  • As fragmentation decreases through consolidation, multiples can skyrocket.
  • Once the fragmentation has been wrung out, where will the next generation of growth come from?
• Some fragmented industries that were mentioned as undergoing PE consolidation: landscaping services, specialty physician practices, industrial crating.
• Add-on deals don’t have to smaller than the core operation although The Merger Verger notes that the integration can be more subtly complex with the egos of the newer larger company clashing with those of the smaller original company. We’re bigger and stronger than you. Yeah, but we were here first, doing fine on our own, thank you.
• When doing add-on deals, the question of branding looms large. It is highly possible that a small local brand carries more value in its market than a larger, more visible one. Landscaping services was an example of this.
• On the question of making acquisitions during economic downturns, most of the roundtable presenters felt that it was important to carry on. One presenter saw downturns as an opportunity to average down their purchase multiples.

• Conversely, both presenters and attendees noted that many middle market sellers don’t pay that much attention to multiples; they focus on price. (Multiples do not affect a seller’s retirement plans; raw dollars do.) In that context multiples can get ugly in a downturn.
• While the topic of integration was listed on the agenda, it got – as it often does – a short shrift. There is still this sense that getting through closing is the Win. It is not. The Verger repeats: you will have a vastly more predictable and successful outcome if you actively manage the “hows” of integrating your add-on deal:
  • How are we going to realize the strategic intent behind this deal?
  • How are we going to avoid the identified risks factors?
  • How are we going to keep the best producers of the target company?
  • Exactly how are we going to get our products selling through their channels?
  • How are we going to make their square product design (or production or management or culture or sales) peg fit into our round hole?
• Seller-entrepreneurs like the Buy-and-Build strategy:
  • They believe the buyer better understands “their baby”
  • It’s easier to get buy-in on visions and plans and investment
  • If the deal involves contingent payments, they have more faith in the the potential payoff
  • “Buy-and-Build” just feels a lot more appealing than “Slash and Burn”

Buyers like the B+B strategy.  Sellers like it too.  It may not be for every PE firm but it’s here to stay.

“Bravo,” says The Merger Verger.  And Bravo to M&A East.

How to Lose a Championship

It’s SuperBowl Weekend (woohoooo!) … that magical time of the year when all of life can be distilled down to sports maxims and 100-yard metaphors.

The Merger Verger’s favorite? This one:

Defense Wins Championships

Now, we get the universality of many sports maxims but as business guidance that one is a disaster, particularly in the context of M&A.

As every successful acquirer knows, good deals begin with good strategies. A good strategy gives rise to solid value drivers, which enable sharper focus and clearer future goals. It paves the way for asking more action-empowering questions in due diligence, which results in more effective solutions. And all that tends to lead to a more successful outcome for your acquisitions.

That part of M&A is as basic as it gets.

But…

Defense is Not a Strategy

Defense is an awareness, a tool for protecting your flanks (and your backside). It cannot and will not ever power you forward.

If the reason to do a deal is primarily defensive – to react impulsively to some competitor’s move or prevent The Other Guy from buying some company – what, pray tell, do you do with the target once you’ve got it? On what basis do you make future decisions when in the mere act of closing you accomplish the only strategic objective that your action permits: allowing you to say, “We won?”

Defense may shape the outcome of Sunday’s game. But its value in doing deals is basically nil.

If your primary strategic objective is to keep a target out of someone else’s hands, “man up” and walk away. The truth is that too many good deals go bad. A bad deal (meaning one based on a bad strategy)? That is one trophy you can enjoy watching The Other Guy win.

Role Models:

Success:      P&G acquiring Gillette

Failure:        eBay acquiring Skype

TBD:             CVS acquiring Aetna

Do Diligence … All of It

Analysis: The Merger Verger recently conducted a Google search on “due diligence.” In approximately one half a second, 36 million results popped up. We took a quick look at all of them and found that of those relating to M&A 98.7% deal with legal and financial due diligence. Digging a bit further we found that of M&A results 93.4% offer the same information within one standard deviation.

Conclusion: even The Pinball Wizard could conduct a tolerable-good due diligence investigation into the legal or financial aspects of an acquisition.

Tommy can you see me?

But strategic and operational due diligence … well, that’s another matter altogether.

For less experienced acquirers, The Merger Verger worries that they may make inquiries about what due diligence to do only to be told not to worry about it, their lawyers and bankers and accountants have it all under control. “Okay, good,” they might reasonably say.

Unfortunately, that sad little exchange explains why so many deals fail … because legal and financial due diligence do not – as a rule – probe the strategic and operational issues that are the foundation of (1) making a sensible deal and (2) making it actually work.

It is one thing, for example, to know how a sales force is structured and how they are compensated and even which salespeople are the most productive but it is another thing altogether to know how the sales people sell and how they interact with the product design people or if the selling process requires a deep solutions orientation or merely efficient order taking. It’s all different.

Your lawyers and accountants can ask all the “what” and “who” and “where” questions in the world about your acquisition target but if your operations people don’t ask the “how” questions your deal is doomed.  (The point here is not to besmirch lawyers or accountants but to face the fact that this kind of due diligence is outside their normal scope of work.)

Strategic and operational due diligence provide the information upon which a successfully closed deal becomes a successfully done deal.

It begins with understanding how you, the buyer, function and then asking the questions you need to know to understand how to make you and the seller function together. If you don’t have the time to develop the “how” questions or probe the answers or enact the solutions yourself, GET HELP. You will tilt the otherwise very long odds of acquisitions in your favor. The Merger Verger guarantees it.

 

About the Art: The original album cover from The Who’s rock opera Tommy and a detail of a 1951 Genco Tri-Score woodrail pinball machine (courtesy of Mystic Pinball, www.mysticpinball.ca)

Afterword: it’s probably not that great an idea to quote any of the statistics cited in the opening paragraph of this posting.  We made them all up. “Illustrative fiction” from TMV!

Gunslinger Wisdom – 2

The quote below comes from PRITCHET, LP, a post-merger integration consulting firm based in Dallas. They use the metaphor of a gunslinger to describe those who would succeed at managing mergers.  (The Merger Verger likes the metaphor and has used it previously here: Gunslinger Wisdom.)

During a merger, you need to become a bit of a gunslinger. There is real danger in waiting from problems to “draw first” … and you don’t have the luxury of taking time to aim perfectly.
We’re not advocating that you proceed with wild abandon,
but we do want to emphasize that the conservative, slow, methodical approach typically doesn’t cut it in a merger environment. That can be the most reckless strategy of all.

The Verger agrees with the good folks at PRITCHETT; they are correct that too much can go too badly wrong with a wait-and-see attitude. The idea of taking one’s time “to get it right” is yet another one of those areas where merging companies and running them are two completely different arts.

That said, it is equally important to note one element of their observation that is tucked neatly right in the middle: “We’re not advocating that you proceed with wild abandon….”

Remember Your Day Job

Gregg Stocker, author of the book “Avoiding the Corporate Death Spiral” has this to say about one of the disruptive risks of doing a deal:

Although true of any size company, small companies must be especially careful that an acquisition does not become such a distraction that it pulls management attention away from running the organization as a whole.

Stocker’s observation is true in both the deal-doing process and the integration process but in the latter the converse is also true.  Integrating two companies is a complex, long-running and very challenging process and senior management must not let the day-to-day fires of the underlying organizations keep them too far from it.  Managing a company and a deal is a true balancing act.

Disney Eats Shark, Survives

Thrives, in fact.

The Merger Verger was looking for his Baked Alaska recipe the other day – in a fruitless attempt to impress a third-date woman friend – and what should drop out of the file labeled “recipes” but an article on Disney’s 2008 acquisition of Pixar. What ho, Malvolio!

So, we provide below a few nuggets from The New York Times piece entitled, “Disney and Pixar: the Power of the Prenup.”

The worries were two-fold: that either Disney would trample Pixar’s esprit de corps … or that Pixar animators would act like spoiled brats and rebuke their new owner.

The Verger says: Respect is a two-way street. Trust is a two-way street. But in both cases someone has to go first. Disney went first and that was the key to getting the deal right: they respected the unique culture and needs of Pixar and made that respect clear in words AND in ink. It makes perfect sense to expect the acquirer to go first. (Side note: that is one of the reasons why “mergers of equals” tend to fail; neither side wants to bend first.)

[Robert A. Iger, the new chief executive at Disney] … won some early support at Pixar by talking candidly and clearly about the [unpleasant] lessons he learned when his previous employer, the ABC television network, endured two takeovers.

The Verger notes: As the leader of the buyer, Mr. Iger knew that he had to convince the unconvinced. He used candor and personal experience and he did NOT sugar coat it. If your target’s people are smart enough to do something that you want to have, then the chances are good that they’re also smart enough to see through sugar coating.

Don’t do it.

Mr. Iger also agreed to an explicit list of guidelines for protecting Pixar’s creative culture. For instance, Pixar employees were able to keep their relatively plentiful health benefits and were not forced to sign employment contracts. [He] even stipulated that the sign on Pixar’s front gate would remain unchanged.

The Verger notes: While the extent Disney went to may be over the top for industrial companies, for creative companies and service businesses it may not be. Keeping good people is in the details: health plans and signage; Disney even let the Pixar folks keep email addresses with the Pixar name rather than converting them to Disney.com. It’s the little things that evidence to people that you will do right when the big things arise. And this: Iger made a written contract about what he was going to do and not do; but he didn’t make his “new underlings” do the same.

And finally:

The key to successful integration, analysts say, has been Mr. Iger’s decision to give incoming talent additional duties. … “If you are acquiring expertise,” he told The Times, “then dispatch your newly purchased experts into other parts of the company and let them stretch their legs.”

The Verger notes: how better to let your new people know that you value their wisdom and their creativity than to put it to use on a bigger stage?

Obviously there’s some risk of professional dilution in letting people loose on too many projects, but giving acquired staff an opportunity to soar right when they are at their most worried can go a long way towards ensuring that your best talent doesn’t suddenly become your competition’s best talent.

About the art:

Top: Finding Nemo, courtesy of Disney

Middle: DK (who cares?)

Bottom: Elena D’Amario of Parsons Dance Company (photo by Lois Greenfield)

Choosing the Right KPIs

One of the most common mistakes that less experienced acquirers make is to apply their company’s standard Key Performance Indicators (KPIs) to the newly acquired target or to the integration/transition process itself.

As The Merger Verger has harped on over and over again, integrating two companies is not like running one larger one. It’s just not. (If you still can’t accept that premise, I suggest you’ll get more out of Archie and Jughead than any further reading of TMV.)

There are three key elements of successfully executing an acquisition:

1. Keeping the underlying business running successfully
2. Keeping the acquired business running successfully (or getting it to that state)
3. Integrating the two successfully

Well, DUH! The point isn’t that that list represents any rocket science on TMV’s part but it evidences why the next concept is so important:

If you’re performing three different activities,
you measure and assess them using three different standards or sets of measurements.

That’s the key here: for your integration you need to “think different.”

Start with these questions:

• What is the strategic intent of my deal?
• What are the keys to achieving that intent?
• What are the impediments or risks to getting there?

The answers to these questions should be the basis upon which all your integration KPIs are developed, quantified and prioritized.

Read that again: KPIs for an integration are about achieving
the core purpose behind the deal: what to focus on achieving, what to focus on avoiding. They are not about measuring the integration against your normal yardsticks; they’re about measuring it against the point of the deal.

Needless to say (but I’ll say it anyway): the intent behind basically every deal is unique. So The Merger Verger can’t tell you what KPIs to monitor.   IT ALL DEPENDS!!

That said, if your acquisition is about revenue growth through expanded territory, for example, track your sales in that territory alone (particularly sales to existing customers’ locations in the new territory), look for growth rates based on new standards not old, watch your new-customer intact; track your regional cross selling, measure after-sale follow through and reorder rates. In each case quantify your KPIs at levels that are appropriate for the new business, not the existing.

If your deal is about new technologies, for goodness sake measure your retention of key innovators but also watch the degree to which existing customer services or solutions are being repositioned with new capabilities, track your training of existing staff on new systems and their translation of that training into sales calls and revenues.

Figure it out for yourself. But THINK DIFFERENT. Focus not on how you’ve done it before but on what and how you measure to achieve the new specific objectives of the deal.

Sales Fails in M&A

In acquisitions, sales can be just plain hard.

The Merger Verger was conversing earlier today with a senior sales executive at a recently acquired technology service provider and the subject of post-merger sales came up. More than half a year into this deal, major sales issues were still causing trouble, down to the level of non-existent goals and undefined bonus formulae.

Hello! Who’s in charge here?

A big part of this challenge sounds like a failure of due diligence or, if known, a set of differing practical issues that got downplayed and dismissed. They shouldn’t have. Turns out that the differences were pretty fundamental… and obvious if one looked.

Here’s the landscape: The buyer and target are in parallel lines of business. There were good revenue synergies and cross-selling potentials in the deal. The companies’ reputations and statures in the marketplace were compatible.

But…

Put it All on Red

The cost of a proper integration process is sometimes off-putting to executives. The problem is that – like many professional services – the ROI is pretty squishy.

That’s just a stupid excuse, in the very humble opinion of The Merger Verger.

The integration effort needs to start soon, ramp up big and go long. That all costs money. Sometimes Big Money. Estimates in the range of 10% of deal value are fairly common.

Executive: “Ten percent? Are you kidding?”

Verger: “No. Face the facts.”

The facts are that well over half of all deals fail to achieve their intended results and many actually destroy shareholder value. Failure percentages range as high as 70-90%. That’s horrible.

So look the old Verger in the eye and tell him that you’re willing to invest 100 cents on the dollar for a deal with a 70-90% likelihood of failure but not 110 cents on a deal that might actually work?

A thorough, effective integration process is an insurance policy … insurance against decades of past failures. That’s the problem: how do you measure the ROI on an insurance policy where the payoff is not measurable at the outset?

You don’t. But you’re corporate executives; it’s your job to make decisions on imperfect information.

That said, there are some proxies to consider:

1. Try this out for a measuring stick. Go home and tell your wife that you’re going to cancel all your life insurance policies because the returns are just too hard to assess positively. She’ll kill you. What’s your return on that?
2. Take a look at the cost of your car insurance as a percentage of your purchase price. It can be 25% or more. Not only that but you hope you’ll never use it! Sure makes paying 10% for something that you will actually use and benefit from seem like a bargain.

Recommendation:

If you are not willing to fund a thorough integration process, go to the nearest casino and put the deal’s purchase price on red. Your chances of a positive return are higher.

Communicating Gut Wrenching Change

Communication [in acquisition integration] is about more than backslapping and ego-boosting. It’s about mobilizing support and removing uncertainty. It’s about honesty and candor. It’s about supplying honest answers to the hard questions that good people ask when they’re in the dark and worried…. Straight talk itself is a highly important value driver. It’s anchored to four firm rules: no secrets, no surprises, no hype, no empty promises.

Source: Feldman, Mark and Michael Spratt, “Five Frogs on a Log: A CEO’s Field Guide to Accelerating the Transition in Mergers, Acquisitions and Gut Wrenching Change”